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Risk Managers' Forum
Tracking cost of risk
A value-added service that pays dividends for both client and agency
By Michael Hay, CRM, CGFM, CPPM
It should come as no surprise to most agents and brokers that the economy is having an adverse impact on their clients’ profitability and on the agent’s individual book of business. They also know that in challenging times it becomes increasingly important to separate themselves from the rest of the pack by providing additional value-added services to their clients. One valuable service is to assist clients with tracking their cost of risk.
Cost of risk defined
Insurance agencies often have the ability to systematically generate and track the client’s cost of risk (COR). The COR reflects in financial terms a company’s expenses associated with identifying, analyzing, controlling, financing and administering risks for a given time period. The components of the cost of risk are:
• Risk management department costs
• Insurance premiums
• Retained losses
• Outside services
Risk management department costs include salaries, benefits, supplies, and capital equipment. Retained losses include passive and active retention and associated expenses. Outside services can include health and safety services from outside providers, third-party administrators, actuarial services, costs of publishing a newsletter, etc.
The components comprising the cost of risk reflect both proactive and reactive expenditures within the risk management program. For example, money spent on risk management salaries, outside consultants, and insurance premiums could be considered as positive (proactive) expenditures and retained losses, both active and passive, as negative (reactive) dollars.
It is only logical to assume that increased efforts to identify, mitigate and fund organizational risks (proactive expenditures) should ultimately result in a lowering of passively retained losses (reactive expenditures). Tracking proactive and reactive components and their relationship to the overall cost of risk yields a more meaningful perspective of the client’s risk management program and provides a justification to maintain a continued investment in its proactive components.
Assist with COR data
Several avenues are available to the agent to begin discussions with clients regarding the economy and its impact on their businesses, but it is usually best to focus initial discussions on immediate issues and concerns. Introduction of insurance as an “equity protection mechanism” is a viable means by which to approach the client and begin a dialogue regarding current operations as well as future plans. The agent can offer to assist clients in identifying historical exposure and loss data and help in planning to reduce the impact of potential losses that would interfere with achieving immediate business goals or long-term financial stability.
An agent can add value by assisting clients with identification of potential sources of data. Whenever possible, existing sources of information should be used. However, if COR information is not readily available, it may be necessary to develop procedures and processes for its collection. The role and extent of participation must be dictated by the client’s need and willingness to include the agent in the process. It should always be remembered that COR implementation is a client initiative, and failure to acquire adequate internal support and management buy-in will usually result in frustration and ultimate failure.
Expenditures should be recorded for the logical risk classifications: human resources, property, liability and budget containment. Due to the diversity of client exposures, it will normally be imperative to involve several departments in identifying sources of information and putting routine data collection mechanisms into place. Other departments can also provide assistance in analyzing and reporting COR information. In most organizations, the accounting and human resources departments play critical roles in the data collection and reporting process.
Establish cost of risk reporting
Once routine data collection mechanisms have been implemented, the agent can work with the client to identify important benchmarks that can provide relevant performance indicators. Simultaneously, the agent can assist in establishing COR analysis and reporting processes. Although many organizations produce an annual COR report, it should be noted that well constructed data reporting procedures will facilitate the capability to utilize the information more frequently. Monthly, quarterly, semi-annual or ad hoc reporting allows ongoing monitoring of COR information and is helpful in making mid-year adjustments based on experience in order to meet end-of-year targets.
The agent can also provide advice and expertise during presentations to management and staff. Knowledge of the client’s exposures, losses and future plans will provide the agent valuable insight into the best insurance options including lines and types of coverage, appropriate deductibles, individual and aggregate stop losses, etc. The agent will normally have better insight into the overall insurance market as well as emerging insurance industry trends and issues. This insight will provide clients with greater abilities to plan ahead and protect their reserves and equities.
Implement benchmarking
Indexing COR data by exposure units is a productive way to compare current operations to historical experience, especially if the client’s business is in a rapidly changing environment. The agent can assist in identifying the most meaningful exposure units for use in indexing and benchmarking.
For example, vehicle damage and liability costs could be compared over time by lane miles driven, number of drivers or number of vehicles operated. Property losses can be indexed against square footage, number of buildings, type of construction, location of facility, etc. Workers compensation costs can be compared by number of employees (full time), employee classifications, employee location, etc. An agent can provide particularly valuable guidance in identifying external sources of information that the client can use for comparison purposes.
The client will receive ongoing benefit by implementing proactive risk management practices capable of responding quickly to internal changes. These practices should also result in reduced losses, which, in turn, will lead to greater financial predictability and enhanced equity stabilization. External benchmarking will afford the client opportunities to monitor performance against competitors and engage in superior strategic planning and to achieve improved market position.
Conclusion
The agent receives significant benefit from assisting the client in implementing a viable COR tracking process. Familiarity with organizational data, exposure units, historical experience and future plans will put the agent in an admirable position to offer the client improved products at reasonable prices. It also will allow the agent to transcend from the role of salesman to one of trusted advisor and consultant.
Finally, the essential value of implementing COR is that of mutual education and understanding. The agent and client work cooperatively to better understand the client’s risk profile and strategic plans. This results in greater understanding of how to best indemnify and stabilize the client’s operations through implementing proactive risk management practices. On this plateau, COR truly realizes its intended purpose, as an important organizational added value process.
The author
Michael Hay, CRM, CGFM, CPPM, is the director of Risk Management Programs for The National Alliance for Insurance Education & Research. He has an extensive risk management background in both the public and private sectors and is responsible for the national Certified School Risk Manager (CSRM) program. Mike lectures throughout the nation on risk management topics and has contributed to several books and magazine articles related to risk management.
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Further information on Cost of Risk can be obtained by participating in the Certified Risk Manager (CRM) and Certified School Risk Manager (CSRM) programs of The National Alliance, or by obtaining the new Risk Management Essentials book. Go to www.TheNationalAlliance.com for more information on all of these programs. |
